Labour formalization: the challenge of designing innovative and responsive incentives

Labour formalization: the challenge of designing innovative and responsive incentives

Raphaël Coin

Africa’s informal economy is one of the most fascinating environments in the world, as craftsmen, clothing manufacturers and street vendors constantly push the boundaries of creativity and inventiveness to make a living. The informal sector is also a major source of employment for the continent’s inhabitants, as 80% of its labour force undertakes activities in this sector, including a majority of women and young people. But while occupations taking place within the informal economy tend to offer an opportunity for generating a reasonable standard of living, they also deprive their workers from a secure income, employment benefits, social protection, and representation in collective bargaining. This explains why self-employment in small unregistered enterprises and wage employment in unprotected jobs often overlaps with poverty.

Countries throughout the world that have experienced rapid economic growth and rapid urbanization have adopted a set of rules aimed at guaranteeing a decent income and working conditions to employees. In this process, the main challenge faced by policy-makers was to pass labour laws that could guarantee the protection and well-being of workers, without raising the costs of the regulatory burden on enterprises in a way that could compromise economic growth.

Labour law: a model inadequate to West African realities

In West Africa, labour laws have existed since the end of the colonial period. In both French-speaking and English-speaking countries, a range of workers’ protections were copied almost word-for-word from the colonizers, including the right to strike, a limit of ten working hours per day, paid annual leave, free health care, and retirement pensions. Unsurprisingly, the measures specified in labour legislation have failed to translate into reality, as the excessive formalism of the law has clashed with the nature of professional relationships in Africa. For example, the rigid working hours and hierarchical relationships inherited from life in factories during the Industrial Revolution turned out to be grossly inadequate with African traditions of flexible schedules and a relationship of solidarity and reciprocal trust between employers and employees.

The informal economy that developed throughout the continent as a result of this mismatch between law and reality then became one of the subjects of the Structural Adjustment Programmes (SAPs) that were put in place by international financial institutions. Led to believe that an overly burdensome legal environment for entrepreneurs was the key factor keeping enterprises away from formality, Mali, Ivory Coast, Senegal and Cameroon all passed acts that emphasized the use of short-term and temporary work, and to ease the conditions of breach of contract. Despite high expectations, SAPs have largely failed to produce the expected outcomes as these flexibilities paved the way for decreasing real wages, increasing workers’ vulnerability, and the shift of many micro- and small-enterprises (MSEs, characterised respectively by less than 10 and 50 employees) towards the informal sector.

Unsurprisingly, the measures specified in labour legislation have failed to translate into reality, as the excessive formalism of the law has clashed with the nature of professional relationships in Africa.

As the mix of Western legal influences failed to take into account the specificities of firms operating within the informal economy, it is no surprise that the legislation, is rarely, if ever applied today. In Niger, despite the existence of two different social security schemes mandated to cover retirement pensions for both public and private sector employees, the participation rate is only 1.26% of the population over 60 years old.

Other countries in the region have used a different approach to labour law by excluding MSEs from various requirements. This is the case of Nigeria where enterprises that employ fewer than 50 people do not have to comply with the minimum wage of ₦18,000 (52,000FCFA) per month. Beyond the fact that the establishment of such threshold goes completely against the principle of equal rights for all workers, one might question the macroeconomic impact of these exemptions. Indeed, while this policy responds to the inability to meet certain short-term costs, the government also sends a signal against enterprise growth and job creation. Indeed, what is the incentive for the employer to engage a 51st worker if he is then forced by the law to apply minimum wage requirements to all of his employees?

Designing an innovative and responsive approach to labour legislation

Although the functioning of labour law in West Africa remains an imported concept, its main function of stimulating economic growth while protecting workers’ rights makes it a goal worth pursuing. This is why public policy should not be based on a choice between regulating and not regulating, but should focus instead on how to regulate. In this regard, the challenge is to find an innovative approach to regulation that encourages labour formalization.

A possible step in this direction would be to integrate a system of incentives for both employers and employees that goes beyond the mere application of sanctions for non-compliance. Economic policy instruments constitute very useful tools to promote State policy by altering the costs and benefits of the choices of actors within the informal economy. They may offer the reward of a subsidy or reduce the weight associated with taxation, in return for compliance. Again, the aim here is to replace coercion and control that have largely failed in West Africa with a system that offers market incentives in order to encourage a desired behaviour.

One of the main obstacles faced by employers operating informally lies in the complexity of business registrations and work-related procedures. In Sub-Saharan Africa, these administrative constraints can be extremely costly and time-consuming. Reducing the expenses associated with registering enterprises and simplifying the requirements for hiring workers by recognizing contracts with more flexibility should thus be considered an absolute necessity. Although such reform might seem difficult to enforce at first, it is interesting to see that other countries have made progress in this regard. In Peru, the Small Enterprises Law simplified access to legal formality through the introduction of the Unified Registration System, which was later reformed under the general Tax-Payers’ Registry. As a result, within 15 years, establishing a small industrial workshop in Lima went from requiring 11 steps, taking an average of 289 days at a cost of around US$1,321 to only five steps, an average of 30 days for no more than US$200.

A possible step in this direction would be to integrate a system of incentives for both employers and employees that goes beyond the mere application of sanctions for non-compliance.

Another strategy involves offering a range of benefits and rewards to those enterprises that recently underwent the path to formalization. Indeed, States may also provide incentives for MSEs owners to register by offering a variety of services and opportunities, such as preferential access to micro-credit institutions and tax exemptions during a pre-defined period . In 2010, the General Act on SMEs in Brazil created the status of “individual micro-entrepreneur” which, in addition to giving access to social security, medical care, and maternity leave in exchange of a single contribution, also facilitated their access to markets and credits. It is estimated that 3 million workers have been formalized in this way.

From the side of employees and self-employed workers, the possibility to obtain a form of social protection constitutes a strong incentive to formalize. But ill-designed or overly burdensome schemes such as the one in place in Niger, tend to increase the costs of compliance and thus discourage both employers and workers to comply with legislation. In this sense, giving beneficiaries the choice of affiliating with different branches according to their needs, from health insurance to monthly pensions to assistance with marriage and funeral expenses, as well as to their contributory capacity would be a highly innovative strategy. Adopting this logic, Welfare Funds have emerged in India in the late 1960s as a collective response to the insecurity and vulnerability experienced by workers. Within 30 years, 50% of workers from the informal economy in the State of Kerala became members of a fund in exchange for mandatory contributions and the scheme has recently been extended to the whole country.

Therefore, the challenge for States is to invent new institutions that offer to those working informally the chance to participate in the design of the regulatory environment in which they will try to operate.

The examples taken from Peru, Brazil, and India should be used as a source of inspiration for West African policy-makers. Together, they prove that a system of innovative incentives that attempt to lower the costs and raise the benefits of formalization can successfully solve the dilemma of labour laws. However, simply copying the legal matrix of a country that recently managed to formalize a large share of its labour force is not likely to produce the desired outcomes.

As seen by the failure of colonial endeavours to protect workers, laws are the very unique product of a society with a set of concepts and notions directly inspired from its own cultural and socio-economic realities. In other words, there is no one-size-fits-all solution when it comes to labour legislation. Therefore, the challenge for States is to invent new institutions that offer to those working informally the chance to participate in the design of the regulatory environment in which they will try to operate. This involves taking a responsive approach to regulation by considering the great diversity of workers’ status in the informal economy and the diversity of the activities they undertake.

A point of departure for an integrated approach to labour formalization

Although thinking about innovative and responsive amendments to labour legislation is important, another inter-related challenge lies in the creation of monitoring and compliance mechanisms that work. To put it differently, the application of labour law, in opposition to its scope and coverage, is critical. In many countries of the region, the lack of capacities in terms of financial resources but also in trained public servants, means that inspectors are often unable to control medium-sized and large enterprises, let alone smaller ones.

Again, examples from other countries can be used as a source of inspiration to overcome this problem. In Chile, owners of micro-enterprises in the clothing production sector who have failed to comply with occupational health and safety standards were offered to substitute a fine for a compulsory training course on how good working conditions can increase a firm’s productivity. In Burkina-Faso, the government has created the Directorate for the Promotion of the Informal Sector with the aim of facilitating MSEs entry into the formal economy through an emphasis on better inspection procedures. Although the creation of new agencies does not guarantee the effective application of the law, it does suggest that States with the necessary political will can develop bureaucratic approaches targeted at better law enforcement in MSEs.

Some countries are showing that the battle to make labour legislation more in line with reality is possible. In Liberia, a country where labour laws had remained unchanged since the 1950s, the Decent Work Bill was signed in 2015.

Undeniably, improving the scope and application of labour law will not be enough to face the immense task of youth unemployment in West Africa. Instead, what is needed is an integrated approach to the formalization of the workforce, with efforts made in providing vocational training programmes, easier access to credit, as well as sustained investment in infrastructure, and good governance reforms. But making labour laws match reality is a good point of departure for three reasons. First, in a region where tax collection is low and economic activity often falls outside official statistics, labour formalization can act as a major catalyst for economic development. Second, the well-being of workers, in addition to being a good in and of itself, is likely to contribute to a more healthy and productive population. Third, an increased application of labour legislation is bound to generate a greater respect for the law in the long-term and thus have a range of positive repercussions.

Some countries are showing that the battle to make labour legislation more in line with reality is possible. In Liberia, a country where labour laws had remained unchanged since the 1950s, the Decent Work Bill was signed in 2015. By forming a National Tripartite Council that includes informal workers, setting a minimum wage that varies depending on the occupation, and simplifying valid employment contracts, Liberian policy-makers have shown that designing a system of innovative and responsive incentives to encourage labour formalization was possible. It is now time for other countries of the region to take similar initiatives.

Raphaël Coin is a graduate in International Political Economy from King’s College London. His main research interests include the design of more participatory political institutions and innovative initiatives for citizens’ engagement in Sub-Saharan Africa.